MANAGEMENT ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2011 NOTES: Section A - Questions 1 and 2 are compulsory. You have to answer Part A or Part B only of Question 2. (If you provide answers to both Part(s) A and B of Question 2, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for this question will be marked). Section B - You are required to answer any three out of Questions 3 to 6. (If you provide answers to all of Questions 3 to 6, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first three answers to hand for these four questions will be marked). TIME ALLOWED: 3 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Please read each Question carefully. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the your answers and the extent to which answers are supported with relevant legislation, case law or examples, where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND MANAGEMENT ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2011 Time allowed: 3 hours, plus 10 minutes to read the paper. Section A: Answer Question 1 and either Part A or Part B of Question 2. Section B: You are required to answer any three out of Questions 3 to 6. Section A - Questions 1 and 2 are COMPULSORY 1. Sean McGrath worked as a woodwork teacher for the past twenty years in Kerry West, VEC. In June 2011, he decided to accept voluntary redundancy and establish a company, Woodenpieces Ltd. Woodenpieces Ltd. will produce and sell wooden sculptures in the Irish marketplace. The company will commence trading on 1 January 2012. Mr. McGrath plans to invest all of his redundancy money, 75,000, into the company. Mr. McGrath has prepared the following budgeted information for the first six months of trading: i) Sales of wooden sculptures can be broken down into two categories, large wooden sculptures and small wooden sculptures. Sales of small wooden sculptures will be made on a cash basis only. Sales of the large wooden sculptures will be on a credit basis with 50% of sales received within one month of sale and these qualify for a 5% early settlement discount. Of the remaining credit sales, 10% will become bad debts and the balance will be received equally in the second and third month after sale. Small wooden sculptures will have a selling price of 50 per unit and large wooden sculptures will have a selling price of 200 per unit. The projected sales, in units, of each are as follows: Month Sales (in units) of Sales (in units) of small wooden sculptures large wooden sculptures January 50 0 February 55 30 March 50 35 April 60 40 May 65 50 June 65 70 ii) Small wooden sculptures will be produced in the month they are sold. The variable production cost of one small wooden sculpture will be 25 and this will be paid in the month incurred. iii) Production of large wooden sculptures will be in the month prior to sale. The production cost of one large wooden sculpture will be 130 and 60% of this will be paid the month after it is incurred with the balance been paid one month later. iv) In January, Mr. McGrath will purchase equipment, costing 60,000 and this will be paid for in April. This equipment will have a useful life of five years. Depreciation will be assumed to be on a straight line basis. v) Fixed production overheads are projected at 3,000 per month and will include the monthly depreciation charge for the equipment. vi) Mr. McGrath has organised for a bank loan, of 24,000, to be received on 1 February. For the first year only, Mr. McGrath will only make monthly interest repayment at a rate of 10% per annum. Thereafter, Mr. McGrath will have to start making capital repayments on the loan. vii) Mr. McGrath will employ one sales person, commencing on 1 January, who will receive a monthly salary of 2,500 plus sales commission of 4% of the total sales value made during the period. The salary will be paid in the month incurred while the sales commission will be paid one month in arrears. REQUIRED: (a) Describe three benefits a company can obtain from implementing an effective budgeting system. (6 marks) (b) (c) Prepare a cash budget for Wooden Piece Ltd., on a monthly basis, for the six month period commencing 1 January 2012, showing clearly the closing cash balance at the end of each month. (15 marks) Explain why the closing cash balance at the end of the six month period will be different to the net profit reported for the same six month period. (4 marks) Page 1 [Total: 25 Marks]
2. (a) Mullingar Ltd. is currently in the process of reviewing its material control system. The Chief Executive Officer of Mullingar Ltd., Mrs. Gillian Gill, stated at a recent board meeting that stock holding costs appear excessive and the company has too much money tied up in inventories of raw materials and finished goods. Having undertaken further research Mrs. Gill now believes that the company should consider implementing either the Just-In-Time (JIT) or the Economic Order Quantity (EOQ) model to reduce stock holding costs. REQUIRED: Write a memorandum to Mrs. Gill addressing the following issues: (i) (ii) Explain the concept of the Economic Order Quantity (EOQ) model and state four assumptions underpinning it. (5 marks) In relation to Just-in-Time (JIT) principles explain each of the following: (1) Elimination of non-value added costs (2) Factory layout (3) Batch sizes of one (4) Zero defects (5) Revision of purchasing arrangements. (10 marks) [Total: 15 marks] OR (b) Offaly Ltd., a company involved in the production of animal foodstuff, is currently in the process of expanding both the range of its products and the number of staff employed. At a recent board meeting Mr. Peter Cox, the Financial Director, stated that the time has come for the company to produce monthly management accounts. Mr. Shane Moran, the Managing Director, replied that before such a decision would be made he needed more information about the benefits of committing to such an undertaking. REQUIRED: Write a memorandum to Mr. Moran in which you: (i) Identify and describe the differences between financial accounting and management accounting. (6 marks) (ii) Describe the functions of management accounting. (6 marks) (iii) List and briefly describe three characteristics of management accounting information. (3 marks) [Total: 15 marks] Page 2
Section B - Answer any three questions. 3. Attempt each of these multiple-choice questions. Only one of the offered solutions is correct. Each question carries equal marks. Give your answers to each section on the answer sheet provided. (i) Pono Ltd. is preparing its budget for the next financial period. The company has prepared budgets based on four different activity levels and has provided the following summary in relation to these: Activity level: Total costs: 14,000 units 95,000 15,500 units 102,500 16,300 units 106,500 16,800 units 109,000 What is the budgeted value of fixed costs for the forthcoming period? (a) 7,500 (b) 11,500 (c) 25,000 (d) 28,000 (ii) The following information is provided for both direct and indirect workers of Wicklow Ltd.: Direct workers Indirect factory workers Basic hours 2,000 hours 500 hours Total hours worked 2,100 hours 550 hours Basic rate per hour 12 10 Overtime premium 50% 50% The total hours worked of the direct workers include paid idle time of 110 hours, which occurred during the normal working day and all overtime worked was part of the normal monthly requirement. How much of the above wages should be classified as production overheads? (a) 3,120 (b) 3,870 (c) 8,120 (d) 8,870 (iii) Barly Ltd. uses 1,000 units, of Material X, per month in its factory. These units cost 2.40 each from the supplier. The cost of placing an order is 40 and the holding cost is equal to 20% of the unit costs for Material X. What is the Economic Order Quantity (EOQ) for Material X? (Answers are rounded to the nearest whole number) (a) 1,528 units (b) 1,846 units (c) 1,414 units (d) 315 units (iv) Which of the following statements is correct? (a) (b) (c) (d) Financial statements prepared by companies for external publication must use marginal costing principles. Financial statements prepared by companies for external publication must use absorption costing principles. Absorption costing principles are used internally in a company for decision making purposes only. A company can use either absorption costing principles or marginal costing principles when preparing their financial statements for external publication purposes. Page 3
(v) Johnson Ltd. has just completed an analysis of the variances that occurred in June 2011. A summary of the material variances are as follows: Material price variance Material usage variance 12,500 Adverse 12,250 Favourable Which of the following statements provides a possible reason for the results achieved? (a) (b) (c) (d) The company purchased a lower quality material which lead to increased wastage. The company purchased higher quality materials but this increased the cost of materials. The company used ideal standards for the establishment of material standards. The company purchased in bulk in order to avail of a larger discount and this lead to an increase in wastage. (vi) Toronto Ltd. is currently preparing a tender for a once-off contract in Dublin. The contract requires 5,000 units of Material C, which is used regularly by Toronto Ltd. Toronto Ltd. has 6,000 units of Material C in stock, which cost 10 per unit. The current replacement cost for Material C is 12 per unit. The net realisable value for the quantity of Material C in stock is 9 per unit. Using relevant costing principles, what value should be applied to Material C in the tender submission? (a) 60,000 (b) 50,000 (c) 45,000 (d) 0 (vii) Meath Ltd. absorbs overheads on the basis of machine hours. Details of budgeted and actual figures for the latest period are as follows: Budget Actual Overheads 600,000 550,000 Output 50,000 units 58,000 units Machine hours 20,000 hours 20,500 hours Which one of the following statements is correct? (a) Overheads were under-absorbed by 50,000. (b) Overheads were over-absorbed by 50,000. (c) Overheads were under-absorbed by 65,000. (d) Overheads were over-absorbed by 65,000. (viii) DFK2 Ltd. operates a process costing system, where the output of Process 1 is transferred to Process 2. The following information relates to Process 1 for the period just ended: Material input Direct labour Production overheads Normal loss Scrap value Actual loss 10,000 kgs at 5 per kg 5,000 hours at 12 per hour Absorbed at 100% of direct labour cost 5% of input 7.50 per kg 600 kgs There was no opening or closing work-in-progress in Process 1 in the period. What was the value of the output transferred to Process 2 during the period? (a) 164,500 (b) 166,250 (c) 170,000 (d) 168,211 [Total: 20 Marks] Page 4
4. Letterkenny Ltd. manufactures and sells components used in the computer hardware industry. The company currently charge overheads to products using a plant-wide rate based on direct labour hours. This method was introduced in 1988 when the company was established and the company only produced one product. Since 1988, the company has invested heavily in advanced manufacturing technologies and has increased their product range. Letterkenny Ltd. operates in a very competitive market and due to current economic conditions they are coming under increasing pressure by their customers to reduce their prices. The company are considering the introduction of an Activity Based Costing (ABC) system and has provided the following information in relation to their three products: Product A Product B Product C Direct materials per unit 100 120 150 Direct labour hours per unit 10 hours 8 hours 9 hours Machine hours per unit 4 hours 6 hours 3 hours Production/sales in units 10,000 4,000 6,000 Direct labour is paid at 14 per labour hour. The company calculates selling price by applying a mark-up on cost of 25%. Details of the overheads of Letterkenny Ltd. are as follows: Machine related costs 246,000 Set-up costs 180,000 Delivery costs 68,000 Quality related costs 64,000 Further information in relation to all three products is given as follows: Product A Product B Product C Number of set-ups 100 30 20 Number of deliveries 1,000 550 450 Number of inspections 200 100 100 REQUIRED: (a) Calculate the unit production cost and unit profit using the traditional approach to costing. (3 marks) (b) Calculate the unit production cost and unit profit based on Activity Based Costing principles. (11 marks) (c) Identify three reasons why Letterkenny Ltd. should implement an Activity Based Costing system. (6 marks) [Note: Figures to be rounded to two decimal places] [Total: 20 Marks] Page 5
5. Dundalk Ltd. manufactures paint by means of two processes, Mixing and Finishing. Raw materials are introduced at the start of the Mixing Process and the completed output of the Mixing Process is transferred to the Finishing Process where additional raw materials are added at the start of this process. Conversion costs are incurred evenly throughout both processes. Dundalk Ltd. uses the First In First Out (FIFO) method for inventory valuation purposes. You are provided with the following information for the most recent financial period for both the Mixing Process and the Finishing Process: Mixing Process Materials input 2,000 kg at 5 per kg Direct labour cost 41,940 Production overheads 20,760 Normal loss 5% of input Scrap value 5 per unit Actual loss in period 200 kg There was no work-in-progress at either the beginning or end of the period. Finishing Process Opening work-in-progress There were 1,200 kgs in opening work-in-progress, which were 60% complete, and these units had the following costs attached to them; Mixing Process costs 44,400, added materials in Finishing Process 2,280 and conversion costs in Finishing Process 2,740. Inputs in period Materials added in period 39,600 Conversion costs 75,200 Closing work-in-progress There were 800 kgs of closing work-in-progress, which were 50% complete. No losses occurred in Process 2. REQUIRED: (a) Prepare the following completed accounts for the most recent financial period: (i) Mixing Process Account (ii) Normal Loss Account (iii) Abnormal Loss / Abnormal Gain Account (iv) Finishing Process Account (18 marks) (b) Explain the difference between a normal loss and an abnormal loss. (2 marks) Page 6
[Total: 20 Marks] 6. Monaghan Ltd. is a medium sized company engaged in the production and sale of garden furniture. During the past financial year demand for all three of their products, Benches, Tables and Loungers increased significantly. The company is currently preparing its budget for the forthcoming period and has just received information from their Norwegian material supplier, that the amount of wood available next year will be 25% less than was available in the current year. The following information in relation to all three products is provided: Bench Table Lounger Selling Price per unit 200 250 180 Costs per unit Direct material - Wood 100 80 60 Direct labour 40 60 40 Variable overheads 10 20 20 Fixed overheads 10 10 10 Notes: 1. The amount of material that was available in the current year was 80,000 square metres and the price per square metre was 10. The price of the wood will not increase in the forthcoming year. 2. Fixed overheads are absorbed into products on a unit basis. Total fixed overheads are estimated at 110,000 for the forthcoming year. 3. Demand for each of the products is forecast as follows for the forthcoming year: Bench Table Lounger 2,000 units 5,000 units 4,000 units 4. The marketing manager of Monaghan Ltd. has suggested that the company should concentrate on producing and selling Tables as these have the highest profit per unit. REQUIRED: (a) Comment on the suggestion by the marketing manager of Monaghan Ltd. (3 marks) (b) Determine the optimum production plan for Monaghan Ltd. and state the profit that it would yield. (12 marks) (c) (d) What is the maximum amount that Monaghan Ltd. would be willing to pay to purchase 3,000 extra square metres of wood? (2 marks) Briefly discuss the following statement: fixed costs are never relevant for decision making scenarios. (3 marks) [Total: 20 Marks] END OF PAPER Page 7
SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND MANAGEMENT ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2011 SOLUTION 1 (a) (i) Compel planning Budgets compel planning. The budgeting process forces management to look ahead, set targets, anticipate problems and give the organisation purpose and direction. Without the annual budgeting process, the pressures of day-to-day operational problems may tempt managers not to plan for future operations. The budgeting process encourages managers to anticipate problems before they arise, and hasty decisions that are made on the spur of the moment, based on expediency rather than reasoned judgements, will be minimised. (ii) (iii) Co-ordination The budget serves as a vehicle through which the actions of the different parts of an organisation can be brought together and reconciled into a common plan. Without any guidance, managers may each make their own decisions believing that they are working in the best interests of the organisation. A sound budgeting system helps to coordinate the different activities of the business and to ensure that they are in harmony with each other. Improve control The budget provides the plan against which actual results can be compared. Results which are out-of-line with budget can be further investigated and corrected. Tutorial note Any other relevant benefit will also be awarded marks. (b) Working 1: Sales of small wooden sculptures Month of sale Units sold Sales value ( ) Jan 50 2,500 Feb 55 2,750 Mar 50 2,500 Apr 60 3,000 May 65 3,250 June 65 3,250 All sales of small wooden objects are on a cash basis and are therefore received in the month of sale. Working 2: Sales of large wooden sculptures Month of Receipt Month Units Sales Jan ( ) Feb ( ) Mar ( ) Apr ( ) May ( ) June ( ) of sale sold value Jan 0 0 - - - - - - Feb 30 6,000 - - 2,850 1,350 1,350 Mar 35 7,000 - - - 3,325 1,575 1,575 Apr 40 8,000 - - - - 3,800 1,800 May 50 10,000 - - - - - 4,750 - - 2,850 4,675 6,725 8,125 Working 3: Variable production cost for small wooden sculptures Month of cost Units produced Cost per unit ( ) Sales value ( ) Jan 50 25 1,250 Feb 55 25 1,375 Mar 50 25 1,250 Apr 60 25 1,500 May 65 25 1,625 June 65 25 1,625 Page 8
Working 4: Variable production cost for large wooden sculptures Month of payment Month of Units Cost Jan ( ) Feb ( ) Mar ( ) Apr ( ) May ( ) June ( ) production produced Jan 30 3,900-2,340 1,560 - - - Feb 35 4,550 - - 2,730 1,820 - - Mar 40 5,200 - - - 3,120 2,080 - Apr 50 6,500 - - - - 3,900 2,600 May 70 9,100 - - - - - 5,460-2,340 4,290 4,940 5,980 8,060 Working 5: Fixed production overheads Monthly depreciation charge [60,000/5yrs/12months] 1,000 Cash fixed production overheads per month [3,000 1,000**] 2,000 ** Depreciation is not included in a cash budget as it is not a cash item. Working 6: Interest charge Annual interest charge [24,000 x 10%] 2,400 Monthly interest charge [2,400 / 12 months] 200 Working 7: Sales commission Month Total sales ( ) Commission ( ) 4% Month paid Jan 2,500 100 Feb Feb 8,750 350 Mar Mar 9,500 380 Apr Apr 11,000 440 May May 13,250 530 June Cash Budget Cash inflows Jan ( ) Feb ( ) Mar ( ) Apr ( ) May ( ) Jun ( ) Redundancy 75,000 Loan 24,000 Sales small (w1) 2,500 2,750 2,500 3,000 3,250 3,250 Sale large (w2) - - 2,850 4,675 6,725 8,125 Total inflows 76,500 26,750 5,350 7,675 9,975 11,375 Cash outflows Var. prod o/h s small (w3) 1,250 1,375 1,250 1,500 1,625 1,625 Var. prod o/h s large (w3) - 2,340 4,290 4,940 5,980 8,060 Equipment 60,000 Fixed prod. o/h s (w 5) 2,000 2,000 2,000 2,000 2,000 2,000 Interest charges (w6) 200 200 200 200 200 Sales person wages 2,500 2,500 2,500 2,500 2,500 2,500 Sales commission (w7) - 100 350 380 440 530 Total outflows 5,750 8,515 10,590 71,520 12,745 14,915 O/bal 0 71,750 89,985 84,745 20,900 18,130 Inflow/ (outflow) 70,550 18,235 (5,240) (63,845) (2,770) (3,540) C/bal 71,750 89,985 84,745 20,900 18,130 14,590 (c) The cash budget only records cash inflows and cash outflows. The above cash flow includes the introduction of capital, the receipt of a loan and the purchase of equipment, all of which will be recorded in the statement of financial position. Net profit for the period will include all costs and revenues that relates to the six month period. Financial accounts are prepared using the accruals concept and includes both cash and non-cash items such as depreciation. Page 9
SOLUTION 2 (a) Memorandum To: Mrs. Gillian Gill From: Trainee CPA Re: Material control system (i) (ii) The Economic Order Quantity (EOQ) is the quantity of goods that a company should order, each time they place an order, in order to minimise cost. Four assumptions of EOQ are as follows: Annual demand is known Holding cost per unit is known Cost of placing an order is known On average the company holds half of the EOQ in stock. Elimination of non-value added activities JIT aims to eliminate waste. The lead time involved in a product includes process time, inspection time, move time, queue time and storage time. Each stage accumulates cost but only process time adds value. Factory layout With JIT the factory floor would be rearranged so that all products manufactured by an orgainsation are grouped into families of similar production requirements. The factory floor is then arranged so that each product family is manufactured in a production group cell. This eliminates a build up of WIP, storage costs and queue costs. Batch sizes of one By changing the factory floor and investing in AMT a company can respond to an order quickly and produce the required amount in one production run. By having set-up times approaching zero there are no advantages in producing in batches thus the optimal size is one. Zero defects Traditional manufacturing companies tended to carry safety stock (buffer stock) to protect against defective materials and to be able to meet new customer orders. With JIT there is a hugh emphasis on quality. JIT recognises that by purchasing quality materials total costs will be reduced (less wastage, storage costs ect). A key component of JIT is the undertaking of regular preventive maintenance. Revision of purchasing arrangements JIT encourages the development of closer relationships with fewer, reliable suppliers and placing longer term purchase orders.. Inventories held held will be eliminated by arranging more frequent deliveries. (iii) (b) (i) Reduction in inventory costs Reduction in the risk of inventory obsolescence Reduction in total manufacturing costs and lower set-up costs Memorandum To: Mr. Moran From: Certified Public Accountant Re: Production of management accounts Differences between financial and management accounts There is a legal requirement to prepare financial accounts. There is no legal requirement to prepare management accounts. Financial accounts are prepared for parties external to an organisation, e.g. banks, revenue and shareholders. Management accounts are prepared to provide information to internal parties to help them with making decisions, e.g. senior management. Financial accounts must be prepared annually and are usually prepared for a twelve-month time period. Management accounts can be prepared as often as is required. Financial accounts only include financial information. Management accounts can include both financial and nonfinancial information, e.g. both the cost and the length of time it takes to make a product. Page 10
Financial accounts report on past events, there are usually prepared based on the twelve-months just finished. Management accounts can analyse the past, present or prepare forecasts for the future. Financial accounts cover the whole organisation, e.g. a company must prepare an Income statement and Statement of Financial Position for the company as a whole.management accounts can be prepared based on individual products, divisions or activities. (ii) Functions of management accounting Allocation of costs for internal and external profit reporting In the preparation of financial accounts the figure for cost of goods and inventory remaining in inventory is required. This information is also required internally by managers for costing purposes and inventory management. Provision of relevant information for decision making This type of information may be routine or non-routine in nature. Routine information relates to profitability of products, services, customers, customers and distribution channels. Non-routine relates to strategic decisions and includes investment decisions, introduction of new products and negotiations of long term contracts with both suppliers and customers. Provisions of information for planning, control and performance measurement Planning involves using activities and resources to meet the goals and objectives of an organisation. Control involves the comparison of actual outcomes against planned outcomes. Performance measurement involves the use of financial indicators to assess performance. (iii) Three characteristics of management accounting information Relevant The information must relate to the decision being taken. Accurate If accounting information is not accurate then misinformed decisions will inevitably result. Timely For effective decisions to be taken, information needs to be reported to management on a timely basis. Page 11
SOLUTION 3 (i) Answer C Tutorial note: Units Total cost High 16,800 109,000 Low 14,000 95,000 2,800 14,000 Variable cost per unit [ 14,000/2,800 units] 5 Fixed cost will be the same at all levels. At 16,800 units fixed costs = (16,800* 5) + Fixed cost = 109,000 Fixed costs = 25,000 (ii) Answer D Tutorial note: Indirect factory workers Basic time [500 hours* 10] 5,000 Overtime [50 hours* 15] 750 Direct workers Idle time [110 hours* 12] 1,320 Overtime [100 hours* 18] 1,800 8,870 (iii) (vii) Answer C Tutorial working 2* 40*(1,000 units*12months) ( 2.40*20%) (iv) (v) (vi) (vii) Answer B Answer B Answer A Answer D Tutorial note: Predetermined overhead rate: 600,000/20,000 machine hours = 30 per machine hour Actual overhead cost 550,000 Overheads absorbed [20,500 MH* 30] 615,000 Over-absorbed overheads 65,000 (viii) Answer A Tutorial note Process 1 account kg kg Materials 10,000 50,000 Normal loss 500 3,750 Direct labour 60,000 Abnormal loss 100 1,750 Production o/h s 60,000 Process 2 9,400 164,500 10,000 170,000 10,000 170,000 Page 12
SOLUTION 4 (a) Total production o/h s [246,000 + 180,000 + 68,000 + 64,000] 558,000 Total direct labour hours [(10,000*10) +(4,000*8) + (6,000 *9)] 186,000 Production overhead recovery rate [ 558,000/186,000 DLH s] 3 per DLH Product A Product B Product C Direct materials 100 120 150 Direct labour ( 14 per hour) 140 112 126 Prime cost 240 232 276 Production overheads ( 3 per DLH) 30 24 27 Production cost 270 256 303 Mark-up 25% - (profit) 67.50 64 75.75 Selling price 337.50 320 378.75 (b) Cost pool Cost driver Cost driver rate Machine related costs 246,000 82,000 M/H s** 3 per M/H Set-up costs 180,000 150 set-ups 1,200 per set-up Delivery costs 68,000 2,000 deliveries 34 per delivery Quality related costs 64,000 400 inspections 160 per inspection ** Machine hours[(10,000*4m/h) + (4,000*6 M/H s) + (6,000*3 M/H s)] Product A Product B Product C Machine related costs ( 3) 120,000 72,000 54,000 Set-up costs ( 1,200) 120,000 36,000 24,000 Delivery costs ( 34) 34,000 18,700 15,300 Quality related costs ( 160) 32,000 16,000 16,000 Total overheads 306,000 142,700 109,300 Total units 10,000 4,000 6,000 Production overhead per unit 30.60 35.68 18.22 Prime cost 240.00 232.00 276.00 Production cost per unit 270.60 267.68 294.22 Mark-up 25% (profit) 67.65 66.92 73.56 Selling price 338.25 334.60 367.78 (c) The current system of apportioning overheads using direct labour hours was introduced when the company produced one product only. Since then the company has introduced a range of products and invested heavily in advanced manufacturing technologies. The company is operating in a highly competitive environment. This means that they need a full understanding of the cost structure of each product. ABC provides this as it examines the overheads that each product consumes. ABC will help with the establishment of selling prices. As company is operating in a competitive market the use of cost plus for the establishment of selling prices may not be appropriate. If Letterkenny has to react to competitors change in selling prices they can only do so by fully understand the minimum selling price (cost). Page 13
SOLUTION 5 (a) (i) (ii) (iii) (iv) Mixing Process Account kg kg Materials 2,000 10,000 Normal loss 100 500 Direct labour 41,940 Abnormal loss 100 3,800 Production overheads 20,760 Finishing process 1,800 68,400 2,000 72,700 2,000 72,700 Normal Loss Account kg kg Mixing process 100 500 Abnormal loss 100 500 Bank 200 1,000 200 1,000 200 1,000 Abnormal Loss Account kg kg Mixing process 100 3,800 Normal loss 100 500 Income statement 3,300 100 3,800 100 3,800 Statement of equivalent units Units units Mixing Process Added materials Conversion costs Opening WIP 1,200 - - 480 Completed this period 1,000 1,000 1,000 1,000 Closing WIP 800 800 800 400 Total equivalent units 1,800 1,800 1,880 Costs this period 68,400 39,600 75,200 Cost per element 38 22 40 Cost of fully completed unit [38 + 22 + 40] 100 Working 1: Value of finished goods Value of opening inventory 49,420 Value of completing opening inventory Conversion costs [480 * 40] 19,200 Started and completed during period 1,000 units * 100 100,000 168,620 Working 2: Value of closing work-in-progress Mixing process materials [800 units* 38] 30,400 Added materials [800 units* 22] 17,600 Conversion costs [400 units* 40] 16,000 64,000 Finishing Process Account kg kg Open WIP 1,200 49,420 Mixing process 1,800 68,400 Added materials 39,600 Finished goods (w1) 2,200 168,620 Conversion costs 75,200 Closing WIP (w2) 800 64,000 3,000 232,620 3,000 232,620 (b) Normal loss is the loss that is expected under normal working conditions. For example evaporation of liquid materials during production. Normal loss must be monitored on a regular basis to ensure it can be fully explained and does not hide any excess wastage. Abnormal loss is the loss that occurs above the expected target level of normal loss. This loss must be investigated fully and corrective action should be taken to reduce the risk of re-occurrence. Page 14
SOLUTION 6 (a) Short term decisions should be based on the principle of relevant costs. A relevant cost is a future, incremental cash-flow. The marketing manager suggests that a short term decision, limiting factor, should be based on profit. Profit is based on the accruals principle, includes non-cash items and if the company follows this proposal they will not maximise contribution. (b) Garden Bench Garden Table Garden Lounger Selling price per unit 200 250 180 Less variable costs Wood ( 100) ( 80) ( 60) Direct labour ( 40) ( 60) ( 40) Variable overheads ( 10) ( 20) ( 20) Contribution per unit 50 90 60 Square metre of wood per unit (100/10) 10 (80/10) 8 (60/10) 6 Contribution per square metre 5 11.25 10 Ranking 3 1 2 Amount of wood available:60,000 square metres Square metre used Square metre left Garden Table [5,000*8] 40,000 20,000 Garden lounger [20,000/6] 3,333 Tables [5,000 * 90] 450,000 Lounger [3,333* 60] 199,980 Contribution 649,980 Less fixed costs (110,000) Profit 539,980 (c) (d) 3,000 extra square metres would be used to produce Garden loungers. The contribution per square metre of wood used in the lounger is 10. Therefore the maximum amount that Monaghan would be willing to pay for the 3,000 extra square metres is [3,000*(10+10)] 60,000 Short term decisions are made using relevant costing principles. A relevant cost is a future, incremental cash-flow. For short term decision making existing fixed overheads are ignored but incremental cash fixed overheads that relates to the decision must be taken into account. Page 15